Gold crash leads to unprecedented physical demand

The monumental short selling on COMEX on Friday and Monday had the desired effect — it took out key technical levels and precipitated a cascade of further selling as traders who were long the June contract capitulated. The selling begat more selling and the rest is history. A classic short squeeze executed to perfection.

The trading decision to short gold was taken, we think, after successful smaller attempts by a few hedge funds in January and December who had “cased the joint” following what appeared to be a 'normalizing economy,' an argument strengthened by gold’s apparent failure to rally on Cyprus, Bank of Japan QE and of course North Korea. It was then a question of timing... On the gold futures exchange, the traders have a gearing of about 20:1 over the physical traders aided in great part by a reduction in the margin requirements by CME last November (they have since reversed that position).

Since then, the Q1 economic growth story has faded fast, but the trap had already been set. The selling on COMEX was large and fast — a really spectacular display of shock and awe. There is no other way.

With gold falling to a low of $1,335, physical demand started slowly but has picked up momentum. The Indian market was the first to respond as prices bottomed (no surprise there — they are always adept at spotting bargains), followed soon after by Dubai, Japan, Europe and now China. Sourcing small denomination bars is now proving difficult as stocks evaporate and dealers can expect to wait between 4 and 6 weeks for fresh stocks from the gold refiners. Premiums on bars, as one might expect, are rising fast.

Rarely has the gold market seen such a clear split, with the paper traders heading south while the physical heads north. The former has the advantage of leverage (via the futures) while the latter has scale.

Most encouragingly for gold bulls has been the resoluteness of gold ETF buyers — a hybrid if you will of physical and paper — who are the real investors and appear to be largely unshaken by the decline; in the week to April 17, ETF holdings have fallen by only 1.8 moz to 80.21 moz in holdings — a decline of about 2%. Figures from the CFTC have not yet been released but we would expect futures selling to outweigh this by a factor of about 300-fold.

Disappointingly on the other hand for gold bulls has been the price reaction to the decline, which again can only be described as lackluster — we would have expected prices to rise to $1,450 (a 50% retracement on the move lower) and then the key technical level of $1,540.

This leaves the market with a large long and large short position — and they cannot both be right — gold is therefore set up over the next few weeks as specs take on investors. Place your bets please ...